Senate bill proposes return of risk-retention for US CLOs

Sen. Elizabeth Warren's proposed Stop Wall Street Looting Act of 2021 includes a provision that would "effectively" reimpose risk-retention standards for U.S. CLO managers, according to the Loan Syndications & Trading Association.

Under a section of the bill addressing restrictions on securitizing high-leverage corporate debt, the bill would define managers of collateralized debt obligations (including CLOs) as "securitizers" and require them to purchase and hold at least 5% of the value of their managed CLOs, the LSTA noted in a news release.

The bill, as written, would again apply the risk-retention standards introduced in the Dodd-Frank Act of 2010 and applied to U.S. CLOs between 2015 and 2018 by federal regulators. A U.S. appeals court in February 2018 overturned the regulations stemming from a 2014 lawsuit filed by the LSTA against the Federal Reserve and the Securities and Exchange Commission.

While the Warren bill has long odds of gaining any traction, the LSTA stated, "it will be important to vigorously advocate" the industry's long-held opposition to risk-retention standards on CLO managers.

The LSTA has previously argued the risk-retention rules originally targeting mortgage securitizations were misapplied to CLOs since managers do not originate and sell the loans held in their vehicles, i.e., "originate-to-distribute," nor do they receive the bulk of their fees until investors are fully paid through cash flows.

Although eliminated in the U.S., risk retention remains a feature in European CLOs and for U.S. CLO deals intending to target European investors.

"With Senate Democrats holding the barest of majorities (50/50 with the Vice President breaking ties), and given the Senate's focus on infrastructure, reconciliation, and many other matters, the [act] is unlikely to get much immediate traction," wrote Elliot Ganz, the LSTA's general counsel and chief of staff.

The LSTA is also noting its concern that the bill would also make changes to the bankruptcy code to dilute senior secured creditor claims in collateralized loans while increasing the priority of claims for unpaid wages, severance payments, employee benefit plan contributions and administration claims.

"Re-imposing risk retention on CLOs, a securitization product with a 30-year track record of success, or unilaterally impairing the value of loan collateral without thoughtful deliberation would be costly mistakes," wrote Ganz.